Corporate bonds are a classic element of most simple investment portfolios.
Definition of corporate bond
A corporate bond is a loan between a group of investors (the bondholders) and a company (the bond issuer).
A corporate bond is an ‘IOU’ which states that the bondholders will be repaid, at a date in the future, with interest.
The original sum borrowed is known as the ‘principal’ amount, and any annual interest payments are known as the ‘coupon.’
The coupon rates of corporate bonds can vary from 2% for safe enterprises to 30% for businesses under financial distress.
As we explain in our definition of a bond, corporate bonds can behave quite differently because their terms and conditions vary. Some corporate bonds repay the principal and interest, whereas some perpetual corporate bonds simply pay interest forever, a bit like an interest-only mortgage.
Why do investors love corporate bonds?
As I mentioned above, corporate bonds are an investor staple. McKinsey estimates that the current value of corporate bonds in issuance is $11.7 trillion US dollars.
If you pick up several of the best investing books – you will notice that all of them will discuss bonds.
Whether you’re saving for retirement or growing your wealth over the medium term, it’s likely that corporate bonds will feature in your asset allocation if you are following a mainstream investment strategy.
Corporate bonds have a lower risk profile compared to shares. This is particularly the case with corporate bonds maturing in less than 10 years time.
A corporate bond’s value is linked to the size and the risk of the payments it offers in the future. Where those repayments are in the short term and aren’t under threat, the value of the corporate bond should be relatively stable, because the outcome for investors is very predictable.
The butterfly effect of news events can have a dramatic effect on the market’s best guess on cash flows 50 years in the future, and thus the price of a share today can fluctuate quite violently.
Corporate bonds act like a stabiliser in a portfolio. When equities have a great year, corporate bonds will likely drag the average performance of the portfolio.
However, when shares exhibit risky behaviour like crashing by 30% in a single year, you may appreciate the price support provided by a basket of more dependable securities.
Interested in other bond definitions?
- Definition of a bond
- Definition of a corporate bond
- Definition of a junk bond
- What is the coupon rate of a bond?